An excerpt of the Examiner’s Report: This was the most popular question in Section A. A key discriminating factor was in the use of analysis to explain at least two reasons for market failure in the market for vaccinations. Most candidates used diagrams to illustrate the reasons for market failure in the market for vaccinations. Candidates who illustrated these reasons on a single diagram tended to give weaker responses than those who used separate diagrams.
There are 2 most commonly cited reasons for the market failure in the market for vaccinations: positive externalities and imperfect information. What surprised me was why the examiners mentioned that candidates who combined the 2 reasons on 1 diagram fared worse that students who drew separate diagrams. Upon closer examination, I realised it could well be that students are ill-equipped to combine the explanation of both positive externalities and imperfect information.
In the above diagram, I combine the market failures of both positive externalities and imperfect information. The crucial part of the explanation is the sequence of explanation. We should first explain the imperfect information first, followed by positive externality.
See sample explanation for imperfect information:
Imperfect information in the consumption of vaccines, results in market failure because consumers are not fully aware of, and hence underestimate the benefit they would gain from the vaccines. For instance, consumers might not be fully aware of the prevalence of the infectious diseases and underestimate the ease of infection. Consequently, individuals might decide that it is unlikely that they catch the diseases and underestimate the actual marginal private benefit (MPBactual) of getting vaccinated, resulting in a perceived marginal private benefit (MPBperceived) that is lower than MPBactual. If consumers have perfect information on the benefits of vaccination, they would have consumed at Qa, where MPBactual = MPC showing that there is under consumption due to imperfect information since market equilibrium output is a lower level of Qp.
See sample explanation for positive externality:
Assuming that there are no negative externalities, MPC equals to marginal social costs (MSC). Consumption of vaccination however, generates positive externalities in consumption (MEB). Positive externalities in consumption can be defined as third-party benefits resulting from the consumption of a good / service. Third parties are not directly involved in the consumption or production of vaccination. When individuals get vaccinated, it prevents infectious diseases to be further spread within society and contributes to the development of the herd immunity which enables 3rd parties such as babies who are unable to be vaccinated to avoid contraction of harmful diseases. With the presence of MEB, there is a divergence between the marginal social benefit (MSB) and MPB. In particular, the MSB is higher than the MPB. This is illustrated in the above diagram where the MSB lies above the MPB, with the vertical distance between MPB and MSB representing the MEB.
See sample explanation for welfare loss resulting in market failure:
The socially optimal output, 0Qs, is where MSC = MSB whereas free market equilibrium is at a lower level at Qp as observed in the above diagram. Between 0Qp and 0Qs, MSB > MSC. As such, at output level 0Qp, society values an additional unit of vaccination more than what it would cost society to produce it. Society desires more consumption of vaccination, hence, when left to the market forces, there is under-consumption of vaccination by QpQs amount or there is an under-allocation of resources to the consumption of vaccination. By summing the excess of the area under MSB over the area under MSC for the units QpQs, we arrive at a monetary measure of welfare loss (also known as deadweight loss) of area ABC to the society.
By explaining the imperfect information first followed by positive externality, I would be able to point out the underconsumption of Qa - Qp is due to imperfect information, and the underconsumption of Qs - Qa is due to positive externality. It will also be evident from the diagram that the welfare loss is the combined deadweight loss of the underconsumption of Qs - Qp which is due to both imperfect information and positive externality.